The S corporation election is the most recommended and least explained move in small-business tax. The pitch is simple: pay less self-employment tax. The reality is a trade between that saving and a set of new costs, and whether it pays depends on numbers most people have never run. Here is the calculation.
What the election changes
A sole proprietor or single-member LLC pays self-employment tax on essentially all business profit: 15.3 percent up to the Social Security wage base and 2.9 percent above it. After the election, the owner becomes an employee. Salary is subject to the same employment taxes, split between the company and the owner, but profit paid out as a distribution is not. The saving is the employment tax on the distribution portion.
A worked example
Take a consulting business with $150,000 of net profit and one owner. As a sole proprietor, self-employment tax is roughly $21,000 (15.3 percent of 92.35 percent of profit, all of it under the 2026 Social Security wage base).
As an S corporation paying the owner a $75,000 salary, employment tax on the salary is roughly $11,500 across both halves. The remaining $75,000 is a distribution with no employment tax. Gross saving: about $9,500.
Now the costs. Payroll service and filings, roughly $1,500 to $2,500 a year. A separate business return on Form 1120-S, roughly $1,000 to $2,000. State fees vary; Illinois charges S corporations a personal property replacement tax of 1.5 percent of net income, about $2,250 here. Net saving in this example: somewhere between $3,000 and $5,000 a year.
The salary has to be reasonable
The IRS expects the owner’s salary to reflect what the work would command from an unrelated employer. Set it too low and the distribution can be reclassified as wages with penalties attached. There is no formula; industry pay data, hours worked, and the owner’s role all matter. A defensible number, documented at the time, is part of the election.
Where the math tends to turn
Below roughly $50,000 of profit, the fixed costs usually eat the saving. Between $50,000 and $100,000 it depends on the reasonable salary and the state. Above $100,000 the election usually pays, and the saving grows with profit because the salary does not have to grow in proportion.
What it does not do
The election does not reduce income tax; profit is still taxed to the owner. It does not create liability protection, which comes from the LLC or corporation itself. And it adds obligations: payroll deposits on a schedule, a March 15 filing deadline, and basis tracking for distributions.
Running it for your business
The analysis takes your actual profit, a salary figure you can defend, your state, and the costs you would actually pay. We run it before recommending anything, and if the election works, we file Form 2553 and set up the payroll. See S Corp Election and Entity Structuring.
This article is general information about tax and accounting topics and is not advice for your situation. Rules change; check the published and updated dates above and confirm current law before acting. Reading this article or contacting Gordon Tax does not create a client relationship.